ISM Contracts: New Recession Under Way?

Includes: EFA, SPY
by: Alan Hartley, CFA

The Institute for Supply Management reported its June ISM Manufacturing Purchasing Managers Index this morning. The ISM PMI fell to 49.7-below the critical 50 mark, a figure above which the economy is deemed to be growing and below which it is deemed to be contracting. Many have heralded the data as proof of an ongoing or imminent recession. The news has put downward pressure on the two largest exchange-traded funds, the SPDR S&P 500 Fund SPY and the iShares EAFE Index Fund EFA.

Is this what the data portends? Not necessarily.

Since the index's 1948 inception, there have been 11 recessions. The ISM PMI has gone negative (from an above 50 to below 50 reading) on 37 separate occasions. On the 10 occasions the PMI "predicted" a recession, the average lead time was five months. The PMI stayed positive for the first nine months of the 1974 recession before turning negative. There were, however, 16 periods of ISM PMI readings below 50, which did not lead a recession by any reasonable measure of time. Ten positives, 16 false positives, and one nine-month stretch of positive figures inside of an actual recession. On its own, the ISM PMI cannot, with a high degree of probability, predict a recession.

That isn't to say that a recession isn't imminent. But this data point alone cannot be used to make that case, certainly not after just one negative reading. Time will tell, but the ISM Manufacturing Index hasn't.

Disclosure: Black Cypress has long positions in EFA.